The Securities and Exchange Commission has proposed amendments to Rule 206(4)-2, the custody rule under the Investment Advisers Act of 1940, intended to provide additional safeguards to clients and investors and give the SEC better information about the custodial practices of registered investment advisors.
A key element of the amendments is to require all advisors that have custody of client assets to undergo an annual surprise examination by an independent public accountant. The proposal also requires the annual surprise examination in the case of advisors to pooled investment vehicles (e.g., hedge funds and private equity funds) where the advisor is deemed to have custody of the assets. Currently, so long as a pooled investment vehicle undergoes an audit at least annually, and its investors receive audited financial statements within 120 days of the end of its fiscal year, no additional surprise examination is required. The proposed amendment also clarifies that if a registered investment advisor is relying on the annual audit of a fund over which it has custody to avoid having to provide (or having a qualified custodian provide) investors in that fund with quarterly account statements, then the fund must also undergo a liquidation audit and distribute audited financial statements promptly after the fund liquidates and makes final distribution payments other than at a year end.
For registered advisors who maintain custody of client assets with a qualified custodian affiliated with the advisor, the proposed amendments would treat the advisor as having direct custody of the client assets, applying all the requirements of the rule to that advisor and custody arrangement, and add the additional requirement of an annual “internal control report” by a Public Company Accounting Oversight Board registered independent public accountant. The proposed rule changes also include various requirements to report information to the SEC.
Click here for the proposed amendment.